The Problem of Hidden Taxes in a Democracy

One of the basic principles of tax policy is transparency—it should be clear to taxpayers who’s being taxed and how much. If we expect voters in a democracy to make good choices about the level of government spending, they need to understand the full costs of it. Economists call this “tax awareness,” and it’s fundamental to good tax policy.

The current issue of Tax Notes reports on recent testimony of Milton Friedman to the President’s Tax Reform Panel about the hidden nature of a tax regime he helped design during WWII—federal income tax withholding:

Milton Friedman doesn’t like withholding. Speaking before President Bush’s Advisory Panel on Federal Tax Reform recently, the Nobel Laureate and conservative icon urged members to dismantle this pillar of the modern tax system. Collection at source undermines tax consciousness he insisted, obscuring the cost of government and curbing individual freedom…

[W]itholding makes things entirely to easy. By insulating the taxpayers from their tax bills, it vitiates the bonds of healthy fiscal stewardship. After all, how can we starve the beast if we don’t know how much we’re feeding it?

Regulations to assure consumers make smart choices about breakfast cereal are common. Shouldn’t we expect the same standard of disclosure for federal tax policy that disposes of trillions of dollars annually?

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